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The Sins of 2008-09

Why have we seen no prosecutions? A citizen would think after all the recriminations hurled by Washington at the financial community over the 2008-09 financial crisis that by now some executive somewhere would have faced charges of some kind. But no. After the colossal lapse of standards and financial irresponsibility surrounding sub-prime mortgage losses, the authorities have put no one in the dock. Instead they used taxpayer money to secure firms and by implication the individuals who run them. Few companies have faced bankruptcy. Boards of directors, those who by custom and law are ultimately responsible, have seen little turnover, barely 10 percent in fact. It does seem strange. President Barack Obama, Senator Elizabeth Warren, and countless other political figures have poured out a torrent of vituperative rhetoric but have doled out no punishment. Especially since so many people suffered so greatly in the ensuing recession, it is only human to ask why.

Media discussion has floated several explanations, largely dependent on the political biases and the economic status of the speaker. Folks without status and position — Trump supporters on the right and Sanders supporters on the left — tell us that politicians went easy on financial executives because they belong to the same moneyed class. They also suggest that the politicians wanted to protect the flow of campaign contributions. Those closer to the decision makers, condescendingly explain that matters are more complex, even those who lean left. They tell us that the substitution of rescue for legal action was all that kept the crisis from spinning out of control and that in any case it would have been impossible to identify which individuals were responsible.

Matters indeed were and are complex but not in the way that the authorities and senior financial executives say. The problem is that the political class was and is afraid that prosecutions, even bankruptcy proceedings, would reveal how thoroughly their policies and directives contributed to the crisis. Had they attacked financial executives substantively as thoroughly as they did rhetorically, those executives would have had no choice but to fight back, pointing out in the process the ways in which Washington shared guilt in the disaster. The politicians wanted to avoid such counteraccusations at just about any cost. So they talked tough in front of the cameras and while reporters kept their notebooks open, but otherwise helped those in the financial community, at least the senior executives, keep much of what they had as a kind of bribe not to reveal too much.

Certainly, the authorities had plenty of material that would have supported disciplinary or even criminal action had they felt free to move. Bankers at all levels had imprudently abandoned lending standards to give loans to so-called sub-prime borrowers who were unlikely to meet their obligations. They got fees and high rates from these questionable loans but in the process put their firms and the financial system at risk. Such behavior may not be criminal, but it surely violated regulatory guidelines and warranted discipline. Worse, they packaged these dubious loans into securities that they sold to the government agencies, pension funds, and other financial institutions, spreading risk through the system and raising doubts about the financial viability of every actor in it. Credit rating agencies facilitated this unethical and perhaps fraudulent behavior by irresponsibly giving high rankings to these less than safe securities. In the teeth of this risk taking, financial institutions relied on dubious financial derivatives, such as credit default swaps, to push the unsupportable danger of loss onto others.

Guilty as financial people were — and this is only a sketch of the nonsense that went on — they were not alone. The authorities that in a well-ordered world would have prevented such behavior were in fact encouraging it, even facilitating it. Take, for instance, the dubious mortgage loans the banks were making, to the so-called sub-prime and Alt-A borrowers. Washington all but demanded that the banks make lots of such loans. For decades, the government had encouraged home ownership and sought to stop banks from disguising discrimination behind a mask of lending prudence, a practice called red-lining in which they refused to advance mortgages to buyers in certain neighborhoods. At first the moderate government pressure seemed appropriate. In 1992, however, Washington became much more aggressive. With the passage of the Housing Community Development Act, the two government agencies that supported mortgage lending, the Federal National Mortgage Association (FNMA) commonly called Fannie Mae, and the Federal Home Loan Mortgage Corporation (FHLMC), commonly called Freddie Mac, were effectively ordered to provide some 30 percent of their resources for such lending. Earlier in this century, the two agencies set that percentage higher to 50.

However well meaning, this goal increased risk throughout the financial system and implicitly encouraged regulatory neglect and failure. Since Fannie and Freddie primarily supported mortgage lending by buying packages of loans from the banks, they had to lower their standards dramatically, effectively transferring the risk the banks were taking to the taxpayer. The bank regulators meanwhile had difficulty reconciling risky government mandates with their otherwise stringent capital and reserve requirements on lenders. And since these bank regulators were eager to get the risky assets off the books of their charges, they and others in positions of oversight turned a blind eye to the easy practices of the rating agencies that so helped to transfer the risk that the banks were taking to others in the financial system who perhaps were not the responsibility of the bank regulators. For the same reasons these regulators looked less carefully at the exotic derivatives, like credit default swaps, used to spread risk.

There may be little criminality in such behavior, but it was irresponsible and a dereliction of duty. It was a significant enough contribution to the mess to impel both politicians and bureaucrats to hide the record as best they could. The “optics” were bad, as they like to say in DC. One way to keep eyes off their record was to castigate Wall Street and the financial community very publically but not to push financial people into a position where they had to push back, especially legal actions, including bankruptcy, where both elected officials and bureaucrats would lose control of the narrative. So instead they bailed out banks with taxpayer money. They resisted bankruptcy not, as they said, because it would cause the system to seize up. Bankruptcy, after all, does not stop a firm’s operations and the system seized up anyway. The danger of bankruptcy was that it would cancel all contracts, including generous executive compensation and severance schemes, turning financial executives from allies in the deception into enemies.

No one player bears all the blame in the 2008-09 financial crisis. There is plenty to go around. History, if it is honest, will no doubt record it as a sordid affair in which those in powerful positions used taxpayer monies and other public means to cover their poor judgement and worse behavior and secure their positions while only innocents, working men and women, paid by losing their jobs and otherwise suffering in the ensuing great recession. Similarly, all the judgements and fines since have fallen not on the executives but on the shareholders.